Afficionados of Indiana Jones will know exactly which sequence provides the perfect accompaniment to Kwasi Kwarteng’s Growth Plan announced last Friday. Towards the end of Indiana Jones and the Last Crusade, when Jones has to cross an unbridgeable crevasse he does so by stepping out with a leap of faith into the void. As his supposedly dying father says — to the audience, not Indy, who is too far away to hear — “you must believe”.
Jones, of course, crosses with no great difficulty. Whether our Chancellor of the Exchequer will be quite so fortunate is debatable. Like Jones, Kwarteng has made a leap of faith. Like Jones, he is hoping that a hitherto-invisible bridge will prevent him from plunging into the economic void.
Kwarteng is certainly right to lament the loss of economic momentum over the last decade or so. But headwinds in the form of an ageing population and an absence of decent productivity growth have been tricky to reverse either because the required policies were controversial — higher immigration rates for people of working age — or, in the case of productivity performance, because the required magic powers were in short supply.
These headwinds, however, are what Kwarteng will have to overcome if he is to meet his growth objective. The idea is for the UK economy to reach a 2.5 per cent annual real growth target, a radical reacceleration compared with the 1.1 per cent average recorded since the pre-Global Financial Crisis peak.
The ambition might seem admirable but it’s difficult to think of any relatively wealthy country that has managed such a remarkable transformation. And the policies now being adopted are hardly without risk.
Take the increase in government borrowing (which, disturbingly, the Office for Budget Responsibility has not been asked to opine on). If we were in Eighties Germany rather than 2020s UK, the central bank would have had no hesitation in whacking interest rates up to much higher levels to limit the inflationary consequences of excessive fiscal stimulus.
Will the Bank of England be so bold? Perhaps not if, first, such actions are seen to undermine the growth target, second, the Government claims that its fiscal stimulus will reduce rather than raise inflation (thanks to the energy subsidy) and, third, the Bank itself has persistently argued that our latest dose of inflation is only temporary.
Or consider the judgment of financial markets. The UK now has a whopping balance of payments deficit. It’s another way of saying additional government borrowing depends, other things equal, on the “kindness of strangers”, as described by former Bank Governor Mark Carney. Foreigners are already funding a huge gap between our domestic savings and domestic borrowings: Kwarteng’s policies, other things equal, will make that gap wider.
That makes both sterling and the gilt market vulnerable. The former implies higher import prices and, thus, a worsening of domestic inflationary conditions while the latter implies higher borrowing costs for companies, for households and, of course, the Government. And, if inflation worsens, the Bank of England will become twitchy. The idea that monetary and fiscal policy can be kept entirely separate in these circumstances, as some economists have argued, is frankly nonsense.
To be fair, you might say Kwarteng is only re-establishing good Thatcherite principles: she, after all, pushed for lower taxes, faster productivity growth and a more dynamic, entrepreneurial economy. Yet unlike Kwarteng, she didn’t try to achieve everything in a 25- minute speech. Her first term in office was aimed primarily at the defeat of inflation. Her second term delivered privatisation and reform of the unions. The centrepiece of her third term was Nigel Lawson’s 1988 tax-cutting Budget. That simply wouldn’t have been credible in her first term: indeed, Geoffrey Howe’s 1981 Budget was one of the toughest on record.
Liz Truss, Kwasi Kwarteng and the rest of a newly installed Cabinet are aiming for re-election by January 2025 at the latest. Selling a dream before then of ever-rising prosperity might make good political sense. Whether voters and financial markets are ready to believe — in line with Jones Senior’s wise counsel — is another matter altogether.
